I have spent many years talking to retirees about their investments. What I have found is that many tend to do really well when share markets rise, but very poorly when they fall. Often the falls wipe out previously made gains.
From this experience, let me share four tips that may improve your investment returns and your retirement:
What return do your assets need to generate to fund your lifestyle?
A sensible approach to investing is to only take on as much risk as is necessary to fund your lifestyle. Without knowing the return you need makes this approach impossible.
Let’s say you were 60 years of age with $1 million in super, had 40 years to live and lived off $40,000 p.a. In this case your assets need to generate a return of approximately 5.4 per cent p.a. (inflation considered).
Equipped with this clear objective you can now make informed investment decisions. For example, would you allocate a portion of your super to off the plan property investments seeking to achieve a 20 per cent return or into a mixture of blue chip businesses paying 5 to 6 per cent dividends?
During the Global Financial Crisis many investors experienced a 40 to 50 per cent loss on their investments. Matters were made worse for those that did not have strong cash flow paying investments as they were forced to sell good assets at very low prices just to fund their lifestyle.
Returning to the example above, it largely does not matter what the share price is on any given day if cash flows of 5.4 per cent are hitting your account.
While most people can tell you the price of the shares they own, very few can tell you their value and this is where many come unstuck.
Price is what you pay and value is what you receive. The key, whilst easier said than done, is only paying a price less than the value received.
Calculating value is not straight forward but to give a simple example, let’s say a business was paying a 10 cent dividend every year and you required a 10 per cent return on your investments. The value of that business to you is no more than $1 (10 cents divided by 10 per cent).
While there are many more ways to manage your risk, here are three simple layers I encourage you to consider:
Layer One: Asset Allocation
Unless you need to achieve high double digit returns every year and you can handle high volatility, consider spreading your investments across multiple asset classes.
The asset classes our clients invest in are:
The rationale is that if say shares were to perform poorly, your other assets, e.g. fixed interest and cash, would provide some protection.
The amount you put in each depends on your answer to “1” above and your tolerance to risk.
Layer Two: Industry Limits
You may only have say 40 per cent of your superannuation in Australian shares however if 100 per cent of this is invested in the financial sector or worse, the mining sector, your risk levels are high.
Different industries perform well at different times. In retirement, I suggest you consider investing in a range of different industries with strong growth prospects.
Layer Three: Individual Investment Limit
I have seen a SMSF that invested $1 million of its $2 million into just one company and that company declined in price by 90 per cent. This was a painful lesson for the members!
There is no perfect formula to work out exactly how much to allocate to each investment but when deciding to buy shares, I would suggest you ask yourself the question: “given the amount I am looking to invest, if this business went bust, how much impact would it have on my overall wealth?”
To give you an idea, no single business in my client’s portfolio represents more than 4 per cent of their overall portfolio.